Repairs, not “improvements,” to tangible property can present businesses with a valuable current tax deduction. Money spent on incidental repairs and maintenance to assets such as buildings, equipment, vehicles or machinery, can be immediately expensed and deducted on the current year’s income tax return. By contrast, money spent to improve tangible property has to be depreciated over a period of years.
The size of your 2017 deduction will be directly affected by whether the expenditure was a repair or an improvement.
Betterment, restoration or adaptation
On the whole, any expense pertaining to an improvement to the building structure or a part of the building systems (such as the electrical or plumbing system) or to other tangible assets has to be depreciated. If the unit of property was bettered, restored or adapted in any manner, an improvement took place.
Under the “betterment test,” you typically need to depreciate any money spent on work that is presumed to moderately enhance (materially) the productivity, efficiency, strength, quality or output of a unit of property or that is a material addition to a unit of property.
Under the “restoration test,” you typically need to depreciate any money spent on replacing a part (or combination of parts) that is a major component or a significant portion of the physical structure of a unit of property.
Under the “adaptation test,” you typically need to depreciate any money spent on adapting a unit of property to a new or different use — one that is contrary to how the unit of property was used at the time your originally placed it in service.
Determining whether something is a repair or an improvement can be tricky, but the IRS has provided a couple of helpful safe harbors to assist you:
- Routine maintenance safe harbor. You can deduct recurring activities that maintain your property in efficient operating condition. The IRS defines these activities as anything (within reason) that your company anticipates performing more than once during the property’s “class life.”
For activities outside the safe harbor, expenses incurred are not automatically depreciated. These expenses will be analyzed according to the general rules for improvements.
- Small business safe harbor. Referring to a building with an original cost equal to or less than $1 million, qualified small businesses can choose to deduct the lesser of $10,000 or 2% of the unadjusted basis of the property for maintenance, repairs, improvements and other corresponding yearly activities. To be eligible, a small business typically accrues gross receipts equal to or less than $10 million.
In addition to an exemption for materials and supplies (up to fixed point), a de minimis safe harbor also exists. For more information on safe harbors and exemptions, plus other ways to maximize your tangible property deductions, please call us at (818) 334-8623 or click here to contact us.